Global Liquidity

As I have spoken of in recent postings, the amount on global liquidity is extremely high and rising exponentially. The result of this is bubbles, bubbles, and more bubbles. The U.S. housing bubble, and the most recent speculations of stock market bubbles in Vietnam, China, and India. Liquidity, created by the central banks in the form of low interest rates and the M3 money supply, is growing exponentially.

I would like to talk about a specific example of this, a growing form of particular investments, and how the end is in sight and the implications which will follow.

It is common knowledge that the Bank of Japan (BoJ) has money lending standards of next to nothing. They have recently hiked their interest rates from .25% to .50%. To compare this for you, the U.S. interest rate is set at 5.25%, and the European Central Bank's interest rate is set at 3.5%.

You can see the lax loan standards set by the BoJ. What are investors doing? Let me tell you. An investor takes out a loan from Japan for next to nothing. Realize that this is pretty much free money. They take their free money and go to Australia among other place. Australia seems to be a popular place for these types of transactions because of the stability of the Aussie dollar and the good yield offered on their bonds. Anyways, they take their free money from Japan and take it to Australia. The invest it in the Australian bonds and receive a 6% return on the bonds. It's free money, and Japan is able to spread its liquidity around the world.

Hedge funds, private investors, and even central banks are taking place in these types of transactions. How long can this game be played, and what is the eventual outcome?

That is a very good question. As I mentioned at the beginning of this post, the BoJ has raised its interest rates to .50%. I expect this trend to continue and look to see interest rates raised to around 1% by the first of second quarter of 2008. That means a stronger yen, and brings us to another part of the equation. When one invests in the above mentioned manner, borrowing easy money from Japan and investing it abroad, they are betting on a weak yen. Remember that you eventually have to repay the loan from Japan. In converting your investment back to the yen, the yen has to be weak for the profits to hold.

Rising interest rates equal a stronger yen, equal less liquidity. Also, all of these loans eventually have to be repaid. The money coming back to Japan means even more strength for the yen. Now the types of transactions in this nature that are currently at large is estimated somewhere between 1-3 trillion USD. That's a wide range, but either way, it's a lot of money.

When all of this liquidity dries up, it will yank investments from all over the world. It will pull liquidity out of markets world wide. This will effect some economies harder than others. Obviously, the economies with more yen supplied investments in it will be hit harder than others.

There is a lot of Japanese ties up in the U.S. and Vietnamese economy. This ripping of Japanese liquidity from these markets could cause a local bursting of a liquidity bubbles. Those markets will effect South Africa, and the European Union, and so on. These world wide liquidity bubbles are so closely tied, and so fragile. If one of them pops, it will send currency holders world wide running for the exit door. The metaphor means they will run as fast as they can unloading their currency causing a massive decline in currencies around the world. And that my friends, is when gold will open its great wings and soar.

The world wide implications of a global liquidity bubble of this nature are something that I can just guess at. I see recession in the European Union. I see many markets crashing, but this is when I see a true global transfer of power. India and China will survive. Their economies, well based on a lot of excess liquidity, are truly based on true economic growth.