How Much Liquidity is Enough?

Includes: DIA, GLD, IAU, QQQ, SPY
by: Neville Maycock

The subprime crisis that was originally thought not to have a big impact on the economy because it's so small relative to the overall market, today is having a HUGE impact on the economy. After multiple rate cuts by the Federal Reserve, liquidity injections by central banks around the world, and now today's announcement of an agreement with the European Central Bank and the central banks of England, Canada and Switzerland to confront "elevated pressures in the credit markets", we see the credit problems are MUCH BIGGER than what is being told to us.

Some questions to ask after these liquidity injections:

With all this new liquidity, will banks start loaning more to each other? (Hopefully)

Will banks continue to take huge investment risks? (Definitely, as they're shareholders want to see a turnaround and they have the Central Banks to fall back on if their investments fail.)

With all of these rate cuts and liquidity injections have we plowed through record highs in the DOW? (Actually we are right at where we where when the rate cuts first started)

So when it's all said and done, the banks "might" eventually recoup their losses from the subprime mess, but at what cost? Nothing in life is truly free.

All this cheap money will drive up inflation. Don't let the mainstream media fool you saying that inflation is tamed and that minus food and energy inflation is under control. We all eat, use utilities, use a mode of transportation, and buy products that use commodities. So unless you are getting great deals for all of your products and you steal electricity and water from your local utility companies, you are feeling this inflation directly in your wallet.

Even with all this liquidity being put into the market, it doesn't guarantee that we will avoid a recession down the road. If we flood the market with all this liquidity now, what monetary policy tools will be available during a recession (or another major crisis)?

So hopefully this year you've bought some investments to capitalize from this inflationary environment such as gold and platinum. 2008 will be a very interesting year to see the effects of all this cheap money entering the market.