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The [Good] Economic Conditions That Precedes a Liquidity Trap.

The Age of Turbulence:
Plea for a New World Economic Order.

Chapter II.
Keynes' Liquidity Trap: A Theoretical Curiosity.

Paragraph 2:
The Economic Conditions That Precedes a Liquidity Trap.
"The slowdown in economic activity, together with high interest rates, was in all likelihood the most important source of the stock market crash that followed in October.

In other words, the market crash, rather than being the cause of the Depression,as popular legend has it, was in fact largely the result of an economic slowdown and the inappropriate monetary policies that preceded it.

Of course, the stock market crash only worsened the economic situation, hurting consumer and business confidence and contributing to a still deeper downturn in 1930."

Governor Ben S. Bernanke
Money, Gold, and the Great Depression.
At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University,
Lexington, Virginia.
March 2nd, 2004


People usually believe that a Liquidity Trap occurs as a result of worsening economic condition. That can be a costly mistake.


It is widely believed that economic conditions are bad or worsening before a Liquidity Trap. They hence conclude that they will wise enough and be able to unload their position in long-term assets before the Crash.

This is due to the fact that man usually thinks in a linear manner a small change in one parameter producing a small change in another.  If after the Crash the economic conditions are bad they had to be bad before the Liquidity Trap.

However the Liquidity Trap is a non linear event that is caused by a discontinuity of the shape of the yield curve. What is known in te general public as a butterfly effect.

Moreover the Liquidity Trap being caused by an excessive amount of savings the yields the mount of Investments is particularly high.

Because the long-term yields are very low the rate of unemployment [workers compete with capital.] is at an all time low.

Because of the wealth effect, people feel rich as a result of the high price of long-term assets, this economic euphoria is reinforced.

So the Asset Price Bubble caused by low long-term yields, an inverted yield curve and low risk spreads is reinforced by better and better economic conditions.

Given these excellent economic conditions monetary authorities might be tempted to rise their target interest rate, and trigger the Liquidity Trap!


Not only the economic conditions don't worsen before a Liquidity Trap they are even better than they ever were! Watching the macro economic indicator and any measure of risk are of no help in predicting a Liquidity Trap. On the contrary they give a false sense of security.

"The clear evidence of underpricing of risk did not prod private sector risk management to tighten the reins.

In retrospect, it appears that the most market-savvy managers, although conscious that they were taking extraordinary risks, succumbed to the concern that unless they continued to "get up and dance",
as ex-Citigroup CEO Chuck Prince memorably put it, they would irretrievably lose market share.

Instead, they gambled that they could keep adding to their risky positions
and still sell them out before the deluge. Most were wrong.


That is mission impossible. Indeed, the international financial community has made numerous efforts in recent years to establish such oversight, but none prevented or ameliorated the crisis that began last summer.

Much as we might wish otherwise, policy makers cannot reliably anticipate financial or economic shocks or the consequences of economic imbalances.

Financial crises are characterised by discontinuous breaks in market pricing the timing of which by definition must be unanticipated - if people see them coming, then the markets arbitrage them away."

Alan Greenspan
The Age of Turbulence: Adventures in a New World [Economic Order?].

The Economy Feels Good!

All of This Stays True Until the Poor Becomes Richer Relatively to the Rich.
It Will be Proved by The Crash.

My Political Orientation According to Nolan Chart Survey!
As Liberal as John Maynard Keynes!

As Libertarian as Friedrich August von Hayek!

Extreme Economic Conditions Call for Radical Solutions.
The Provocative & Controversial Innovation
Since John Maynard Keynes and Friedrich August von Hayek.

It is of the Uttermost Importance That, When the Crash Comes, Which It Will Inevitably Do, we Restore as Fast as Possible the Economy by Implementing our Plausible Alternative Solution as to Minimalize the Economic Sufferings of the People. Immediately after the Crash I will then start an operation whose purpose will be to
quickly implement my Adjusted Credit Free, Free Market Economy.
To That Order I am Building Redundant Social Networks. Please Grow the Networks!

"Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic.

Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come.

Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before."

John Maynard Keynes, 1st Baron Keynes of Tilton
June 5th, 1883 – 21st April 1946
The General Theory of Employment, Interest, and Money.
Chapter 12: The State of Long-Term Expectation, Paragraph VII.
13tn December 1935
Read the Publisher Agreement.

The Tract will be available from September 17tn, 2009 and I will then retire it from the Internet.
Buy The Tract Now.

© 1994-1995 Shalom P. Hamou.

Long Stocks, Treasury Minerals, Spread Treasuries/Corporate