What is the difference between globalization and liquidity?
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Answer:
would like to start my remarks by distinguishing two different – but related – concepts of liquidity. The first concept of liquidity is related to the easiness with which a certain asset can be converted into cash, which by definition is the most liquid asset. More broadly, it is the easiness with which financial and real assets can be purchased and sold. We can call it “market liquidity”.
In addition to the intrinsic characteristics of the financial instrument, market liquidity is inversely related to the degree of information asymmetry prevailing among economic agents: as shown by Akerlof in his celebrated analysis of the “market for lemons”, a market may altogether disappear (the most extreme form of illiquidity) if information is sufficiently asymmetric. The degree of information asymmetry can vary over time, reflecting both fundamental factors as well as shifts in market sentiment. This is what is happening in the present market turmoil. Liquidity is thus a time-varying variable.
Liquidity has to be distinguished from riskiness. A financial asset can be very risky but at the same time very liquid, if its risk is precisely and broadly understood. Having said this, it is also more likely for a risky asset to be subject to asymmetric information. Therefore, risk appetite and liquidity often go hand in hand. A general re-pricing of risk may be accompanied by shifts in the degree of liquidity of the market.
The second concept of liquidity is the quantity of liquid assets held by households and firms. This reflects, for the most part, portfolio decisions by economic agents in relation to prevailing monetary and financial conditions, the latter linked to, inter alia, the stance of monetary policy. We can call this second concept “macro liquidity”.
Over recent years we have seen a surge in macro liquidity, in tandem with an unusually low level of short and long-term interest rates. In my opinion, and as I have argued elsewhere [1], financial globalisation has substantially contributed to the creation of global macro liquidity. This has been due to the combination of high savings in developing countries such as China, which have increased the appetite for liquid assets (due to precautionary motives and the willingness to accumulate foreign reserves), and insufficient production of financial liabilities, as a result of the still underdeveloped legal and financial technology. The net result of this process may have been a downward push on real (short-term and long-term) equilibrium interest rates, which explains the apparently paradoxical co-existence of strong global growth and low real interest rates. This has allowed central banks in advanced countries to keep interest rates low without igniting inflationary pressures. However, expansionary monetary policies and carry trades may have contributed to temporarily rising global macro liquidity, and it is not easy to disentangle these temporary phenomena from more long-lasting influences.
The two concepts of global liquidity that I have described are different but related. If financial globalisation has been pushing down expected returns, it might also have affected incentives towards risk-taking in financial markets (not only by households but also by financial intermediaries, especially portfolio managers). This is what is commonly referred to as the “search for yield”. It may also have affected the incentives to collect information in financial markets, which (in the spirit of Grossman and Stiglitz) is a commodity like any other and is influenced by market prices (expected returns in this case). Low interest rates may therefore have directly contributed to creating information asymmetries, sowing the seeds for the liquidity problems that we experience nowadays.
The relationship between market and macro liquidity is not necessarily stable. Indeed, in normal times abundant global macro liquidity tends to be associated with high market liquidity, reflecting low interest rates and spreads. However, at times of financial turmoil, market liquidity may dry out even in the presence of abundant macro liquidity if, as is currently the case, the latter is not exchanged
Explanation:
ग्लोबलाइजेशन इज द प्रोसेस वेयर द पीपल गो टू द अदर ट्रेट्स एंड कंट्रीज एंड लिक्विडिटी