John Hussman: Debunking the 'Global Liquidity' Myth

Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

Once a security is issued, that piece of paper thereafter represents savings that have already been deployed in order to purchase investment goods and services (factories, equipment, housing, computers, and so forth).

The security is simply a receipt. It means that at some point in the past, someone produced goods and services without consuming them, and someone consumed or invested in goods and services without producing them. That change of ownership was accomplished by issuing that stock, or bond, or IOU. Again, it represents money that has already been spent – goods and services that have already been deployed.

Now consider government and foreign trade. The U.S. is currently running massive federal deficits, and massive current account deficits. What's really happening here is that we are, in aggregate, consuming more than we produce, and foreigners are producing more than they consume. This difference requires the issuance of a huge volume of new securities to enact that transfer of purchasing power. The resulting mountain of issued securities does not represent newly created money looking for a home, or looking to be spent. It has already been spent! And we've spent it.

Specifically, the U.S. has issued huge volumes of Treasury securities that have been purchased, largely, by China and Japan . There's your global liquidity. It's a monstrous stock of Treasury debt that represents the claims of foreigners on our future production... So yes, enormous volumes of securities, primarily U.S. Treasuries and mortgage securities, have been issued in recent years. Foreigners hold a staggering quantity of the Treasury securities...

To understand the importance of this to the “money on the sidelines” mirage and the “liquidity sloshing around looking for a home” fallacy, notice that as the U.S. issues more Treasury debt, that debt simply must be held by someone. It is clear, then, that we must by necessity observe a rising stock of apparent “money on the sidelines” in the form of Treasuries on the balance sheets of foreign central banks, U.S. corporations, and individual investors. There is no other way... It is not wealth (at least, not to the U.S.) but a claim on future production. Nor it is money that “has to find a home.” It has already arrived, moved in, and in many cases, trashed the place. If somebody sells these bonds to buy stocks, somebody else has to buy the bonds and sell the stocks. In aggregate, no money goes into or out of either stocks or bonds by virtue of such transactions...

This will end badly. “Global liquidity” is not a positive for U.S. markets. It is simply evidence of the existing claims of other nations against our future prosperity. There will be an increasing amount of apparent “money on the sidelines” in the years ahead, for the simple reason that the U.S. government will keep issuing securities and somebody will have to hold them.

Comments

[glendokid:]

I believe that you have made the mistake of assuming that the amount of money is constant. If the Chinese government lowers reserve requirements, the amount of money in China increases. Some of that is, say, invested in US stocks. Does this mean the the Chinese claim on American production has thus increased? No, the Chinese purchaser bought American dollars, thus some entity in the US now has Chinese currency (or equivalents) and thus the US claim on Chinese production equals the claim in the previous sentence.

International economics is hard. The real problem, I think (but not confidently) is that the Chinese government is keeping huge foreign reserves (US treasuries mainly) and thus artificially preventing the Chinese currency from moving higher versus the dollar. they CANNOT present this "claim on US production" else the Chinese currency will go way up and stop their economy because of the loss of exports. See the famous story about John Maynard Keynes and the attempt to make Germany pay reparations after WW I.

2007 Mar 13 02:56 PM