Here's a mental model I find helpful for understanding current circumstances:

"Quantitative easing" means issuing new money -- a government obligation that pays no interest -- to purchase treasury (and agency) bonds -- government obligations that pay interest. Until very recently, for good reasons (a global financial crisis, a global pandemic), the Fed and other central banks around the world have been engaged in quantitative easing at an unprecedented scale, replacing government-issued financial instruments that pay interest (bonds) with government-issued financial instruments that pay no interest (money). The result has been an unprecedented increase in private cash balances -- what many call "liquidity sloshing around."

Last year, some central banks started doing the opposite, "quantitative tightening," i.e., selling previously purchased bonds (or letting them mature), removing liquidity (government-issued money) from financial markets and replacing it, directly or indirectly, with financial instruments that pay interest (government/agency-issued bonds). The result has been a gradual decrease in private cash balances -- one could call it "liquidity evaporating."

For example, you can see the value of the financial instruments the Fed owns (i.e., it has purchased them in the past and continues to hold them) here:

https://www.federalreserve.gov/monetarypolicy/bst_recenttren...

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PS. I'm talking only about readily observable facts, not about "excess liquidity" in the abstract sense, e.g., as described by economists who call themselves Keynesians.

I was hoping that the OP would address a related idea that I find rather weird: it’s sometimes said that “this excess liquidity has to go somewhere” and that “the excess liquidity has gone into [housing/stocks/commodities/other asset class]”.

But I don’t get this: It might seem plausible that if stock prices go up they absorb liquidity from the system. But (ignoring new stock issues / newly build houses) in every transaction there’s both a buyer and a seller. Sure, the buyer parts ways with cash when they buy a share, but that cash goes to the seller. So there should be just as much liquidity as before, just in different hands.

If anything a rising stock or housing market should just put more excess liquidity into the system because it’s possible to borrow against those assets.

What am I getting wrong? Or is this just an often repeated falsehood?

> When the rate of return is high, savers can achieve their goals by buying, holding, and harvesting the resulting cash flow. When it is low, they must turn to other strategies: leverage, arbitrage, momentum trading, more sophisticated quant trading, and “beauty contest trading“: betting on what others will find popular, for (arguably) extra-economic reasons.

I don't think this is how people behave.

I think collective behaviour can be better explained by people discounting the painful lessons of previous downturns the more the longer prosperity lasts. Our brains are wired this way, unfortunately and it requires a conscious effort to objectively (if it can be done at all) take into account risks of serious and long lasting financial winter.

Most people don't have the self discipline to do this. They kinda know about it but then they see other people making shitload of money in risky "investments" and our greedy primate brains take over.

For one concrete data point refer to this[1] chart which tracks the mortgage backed securities (MBS) held by the fed. This is fed creating money (for the lack of a better word) to indirectly fund home ownership. What started out as a short term measure to avoid a Great Depression post 2008[2] crisis ended up being a more permanent policy fixture. That is about $2.7T of new money created since 2008. Let that sink in.

2010s were quite unprecedented years in terms of new money (and hence new debt) created. The repercussions were everywhere; crazy VC funding (Uber/Airbnb etc.,), insane tech salaries, record high stock markets and so on.

[1] https://fred.stlouisfed.org/series/WSHOMCB

[2] https://home.treasury.gov/data/troubled-assets-relief-progra...

It means wages and employment are too high which causes inflation. Nevermind the printed trillions, the common employee is the true enemy here.

If you believe crypto is purely speculative, maybe you can argue it's a near perfect measurement of excess liquidity sloshing around the financial system

Food for thought

I strongly believe there is not one but there are two monetary systems today. One is for assets and the other for daily life consumption. They are only weakly coupled less than maybe in the past. This allowed raging inflation in the asset system for decades while daily life saw deflation or low inflation. And now we have exactly the opposite. There are a lot of reasons - many related to decision body captures - why transmission between the two sides slowed down. Any analysis looking at only one side and trying to explain the whole is bound to fail. Traditional methods work as long as they focus on one side only - influence from the other can be neglected.

The viewpoint in the OP is largely backward.

There is always as much liquidity as is required. "Excess liquidity" flows around until it finds somebody where paying off the loan they hold is the 'best use of funds'. That destroys the liquidity, and the loan - shrinking financial balance sheets and freeing up whatever physical asset collateral that loan is secured upon, which then becomes 'equity'.

Increasing base rates is an artificial market intervention that suppresses asset prices. High asset prices, as with everything else priced high, is just a market signal to produce more of that particular asset.

Asset prices rise until the portfolio indifference point is reached - loans created against asset collateral are matched by loans destroyed by received liquidity created by those loans (as the 'best use' of that liquidity).

All fairly straightforward once you accept there isn't a fixed amount of money and that money and bonds are essentially the same thing with different terms and interest rates.

I don’t fully understand the point the author is trying to make. I appreciate that there are boom and bust cycles for some sorts of assetes

I would have liked to author to talk more about wording. What is actually liquidity? Today’s money appears in many gradual forms of moneyness.

Also is there anything like "excessive money"? Where does it come from? Central banks don’t just print money. They trade it for usually governmental bonds.

If other than central banks have excessive liquidity they may trade it for other assets. This means they need to find a counter party that has the reverse situation. So overall the economy cannot have excessive money.

I've been assuming that the "excess liquidity sloshing around" is all those profits from decades of I.T.-fueled increases in productivity that did not trickle down to have-nots, but rather were accumulated by the haves. More than they can spend, or even invest carefully. So it sloshes.

A good analogy, for those more familiar with mechanics / engineering / physics - https://en.wikipedia.org/wiki/Free_surface_effect

`Liquidity` = `Value` minus `Debt`

`Excess liquidity` simply means we were in the middle period where valuations increased, and debt levels hadn't yet caught up, so new credit was being issued fast, and money from loans was entering the system accelerating the cycle.

I interpret "excess liquidity" to mean that there is a larger than average share of people, businesses, or governments that have enough excess wealth to want, need, or be required to invest that excess wealth.

i.e. There are more people with money that needs to be spent.

I interpret "sloshing around" to be a metaphor for the damage that can be caused to various markets (real estate, stock, etc) by a sudden increase in demand (caused by the above people, businesses, or governments excess money suddenly flowing into a given market).

i.e. When lots of money is suddenly spent in a single market it causes a harmful amount of price inflation.

Until there is a widely available open source model of how the economic system works (here and now) people will go on beating about the bush in eternal cycles.

The elements for this to happen are actually there. We are not talking about a detailed replica with real time data, but a reasonably accurate model that includes all the public data from central banks, private bank statements, public market valuations etc.

With such a system the question "excess liquidity sloshing around" is a specific query with a quantitative answer, not an endless, low-information discussion.

It means greedy people have too much cash and are still looking for investments. They are forced to put money into investments that are less than ideal. If something isn't worth it but you can't find anything else that is the case with everyone else meaning all the shitty assets are going to be driven up. If a billionaire has a billion dollars they are looking to get rid of that trash and find something they can write their name on. They know where that toilet paper came from. I mean money.

This article does a pretty bad job of explaining the concept.

> This is one instantiation of an idea that was omnipresent in 2021-2022—that much of the weirdness in financial markets, from GameStop to crypto to stock market volatitlity, was driven by an excess of liquidity. This idea made a certain amount of inarticulable, pre-intuitive sense, but that sensibility does not a gears-level understanding make.

Seriously? This paragraph is fucking garbage.

This is tangential but I asked it in another thread a little too late. But with the Fed's interest payments exceeding their asset income interest for the first time in history, does this effectively cause an increase in M1 like QE? The official charts seem to imply that the answer is "no" but I don't understand why.

It means lots of new money has been created by loan formation as interest rates have been so low.

Thus assets will see their price rise. Certain hot assets will see large price rises.

This will continue until interest rates revert to the norm (whatever that is) and correctly price risk.

To fight excess cash feds increase interest rates. Excess cash in a low interest rate environment causes inflation because of the multiplier effect of loaning money. The increased rate slows down how much people will borrow.

Examples: the 08 housing bubble, the oil price surge following the 08 crash, securities and crypto boom of 2020

People will try to maximize their gains wherever they can.

Perhaps slightly tangential, what does end-of-life of money look like, or put another way, how is money destroyed (assuming that it is)?

It means that the wrong people have money and that many of them need to be poor and die to reduce inflation

That means: too much money, and it's loosing its worth more quickly.

>What am I getting wrong?

You are correct when taking the view of the financial sector as a whole - every asset purchase merely swaps who has the cash and who has the asset. You're not getting much of anything wrong, merely missing a behavioral trait of many market participants: they desire a fixed ratio between their various financial assets. An extreme example of this is an index fund, which has a formulaic relationship between their book value and how much of what assets they own.

In essence, what happens is that cash gets dumped into the laps of various market participants, who then notice that they have "too much" cash. They then bid on various assets until there no longer is "too much" cash in the system for the total value of assets around.

Keynes divided liquidity preference into transaction demand, precautionary demand and speculative demand.

Transaction demand refers to earning money with a job or business and then spending it. Precautionary demand refers to demand for money based around uncertainty in the future, you keep some money around because you want to insure against losing your job (rainy day fund) and finally, once you have so much money you satisfied these two, there is still the fact that money is the most liquid asset. Money can be traded into other things faster than anything else. So this is basically day trading, buying low and selling high. The problem though is that at some point the Keynesian beauty contest begins. People not only react to fundamentals but also the reactions of other investors making investment decisions. Someone invests because they genuinely believe in the stock,

then people invest because they think people believe in the stock,

then people invest because they think people invest in the stock because people invest in fundamentals.

This is a rationality trap that doesn't end until the bubble pops and then people move onto something else.

What you are concerned about can be explained by a weakened form of a liquidity trap. The problem with the liquidity trap is that it is pretty theoretical in the sense that it is absolute. Like getting 100% efficiency. But in practice a liquidity trap can also be in the form of trapping liquidity in specific economic sectors and that can be described as a continuum.

For example, we separate the economy into the real economy and the financial economy. The financial economy is just a model of reality, but it is possible that messing with the model of reality is more profitable than actually doing something in the real world. This means money is allocated away from the real economy and into the fantasy of the financial economy. People do sell their financial assets but only to buy something else in the financial economy. It is a one way street of money flowing into the financial economy but never back and this is why you need constant government intervention that reinvests the money back into the real economy. It is obviously an ugly solution but what are you going to do? Introduce a wealth tax?

Liquidity means capacity to buy, essentially. Not cash per se.

If you reduce the required deposit on a house from 20% to 10%, that increases the liquidity in the market. Suddenly more people ‘have’ the money to buy that $500k property and the market will typically rise until it’s absorbed that added financial capacity

This is why low interest rates had such a dramatic impact.

Monthly repayments are much lower on a low interest loan, so the average person could ‘afford’ to borrow way more.

Note; this is just Real Estate. Lots of other borrowing also occurred.

But when Real Estate markets suddenly go up by 20%, now it’s the owners of these houses that are worth a whole lot more. And they often decide to cash in, in some way (selling their J

(I'm not an economist) Good, point but think of the following example. You have 10 startups and supply and demands has dictated that $1M is a good price for 10% equity. Now let us say a group of VC suddenly have $20M dollars to deploy. The system only has capacity for $10M, what will play out over time is that VC will bid ever higher amounts for that 10% of equity because they _have_ to deploy capital. It seems silly when outlined like this but imagine this taking place over a few years time and with many complicated variables. It becomes really easy to rationalize that the 10% is really worth $1.2M, $1.4M, etc (there are also some feedback loops here of VCs buying from each other at greater valuation thus justifying their other purchases at higher prices etc). Repeat for X year and you get to $2M.

Of course as you point out that money will go to the seller and does not simply evaporate. Now in the heads of a founders. They could decide to sell less equity (say only 5% to still raise just $1M) but let's be honest, they won't VC will tell you it is a bad idea and the startup down the street is expecting the $2M (again still plays out slowly over time so you don't really notice the slight raises in valuation). The founder can then use that money to do more work (initially) of course the founder has to bid for workers (programmers) which to assume a simplified model is also a finite pool.

The example repeats, this time not for equity but for labor. The programmer is really worth $100K but you _really_ need one and if you don't pay them $110K he will take an over at the other startup. You can afford them after all you just raised $1.2M. This pattern repeats until you have programmers demanding $200K. All of the sudden you NEED that $2M valuation otherwise you cannot afford to hire anyone.

Those programmers have needs to, a house for example, let us assume there are only 10 houses and...

You get where this is going.

This can continue as long as the underlying value of the business can support it (the margins of VC, founders, programmers, etc just decrease gradually). So who loses? The people that are not part of this subsystem that got money injected, the people holding the 'bag' as they say when the bubble pops.

This is essentially a trap that is hard to get out of because there are many different stages in the process each with costs. The programmer can only go work for $100K if the house goes back down in price etc.

I think that's the sloshing part. Excess liquidity moves from entities that buy real estate, into the hands of those that were selling that real estate. Then the excess liquidity of the entities that sold real estate goes into whatever they're interested in, like maybe the stock markets. This is not one big movement but lots of mostly chaotic reactive systems hench the sloshing.

But isn’t the cash’s purchasing power getting inflated away, at say 6.4%, so the liquidity evaporates?

We can all be given millions (super liquid) but that doesn’t make us millionaires in terms of purchasing power. At first it seems like everyone is rich, then folks realize it’s funny money and suppliers raise prices. Since money is (dynamically) valued by what you can buy with it.

So the seller of the house sold for a million, for example, but it turns out they actually have ~850k if they sat on the cash for a couple years.

Many good points in the other comments. One important first-order aspect that is usually meant by “excess liquidity” is central bank stimulus: Central banks create more money (buy low risk assets) -> there is more money in the system that has to go somewhere -> more money in total has to go into riskier assets -> they are worth more. This is a very naive equilibrium argument, and the “excess” probably just means “unusually much”, nothing deeper or technical.

Part of the confusion is, as others have pointed out, that "liquidity" isn't really the same thing as "money".

If you're talking about money, then that's exactly what happens - the creation of "high-powered" central bank money leads to a multiple of that amount of new money appearing in the economy as it's used (and reused) in the financial system to make net new loans (the multiplier effect).

Ultimately as the money gets passed around then some market participants will use the money in ways which reduce either liquidity or money supply or both (repaying loans for example) so there's a decaying effect which is why the multiple isn't infinite. As the money dissipates throughout the system it will end up in the hands of participants who are either slower to reuse it or more likely to put it in something which either is or looks like a central bank deposit - hence the "liquidity" eventually dissipates too.

If there are 1000000 stocks of a company around and a lot of people want to buy and almost no-one wants to sell. If one person manage to buy 10 stocks from another person at 10% above last days price ($100), i.e. at $110, then the total marked value of that company has increased by 10% to $110 * 1000000 = $110 million. So $10M were created driven by a small transaction of just $110 * 10 = $1100.

It's not that all 1 million stocks have to trade for the total value to go up. All the people who did not trade, but who own the other stocks, have seen their (paper) value go up.

And the same, but opposite happens when it goes down of course.

Let's say some major event would trigger a panic on the stock market, then very few trades could cut the total market by 50% and very few would get any money for their stocks at the price when the panic started. Most would not have sold and would sit on stocks worth 50% less than the day before.

Kind of extreme examples here, but just to show what I believe you are "getting wrong".

> > Or is this just an often repeated falsehood?

This is correct. Except for inflation it’s impossible for asset prices to rise everywhere.

Some places and some assets will see a rise while other places and other assets will see a drop.

While everybody was screaming at the everything bubble there were real assets that became defacto worthless (at least temporarily) the entire fleet of passengers Boeings and Airbus. Not to mention cruise ships, casinos, theme parks..

What about NYC real estate? The pandemic had people thinking that life is too short to live in such packed conditions in places so sensitives to pandemics.

Can we also talk about oil which collapsed during Covid and hit a negative 37 dollars per barrel? All commodities did bad during the pandemic, oil, LNG, copper etc.

It’s a form of selection bias because pundits and commentators always watch where the money is going , not places where money is hemorrhaging (that is unless there is a big bankruptcy), but sector wise they just dont focus on it.

A clear example is OPEC. Every pundit focuses on what OPEC does but nobody focuses on what it means for shale oil producers and their survival. The only people who focus on those are their lenders and investors as well as city officials but this profile doesn’t show up on your TV on Bloomberg or CNBC , because these outlets are too busy interviewing the Saudi or the UAE secretary of energy in the aftermath of the OPEC decision

As you grow up you understand they most of phenomenons that people swear by are selection bias.

There are theories that even stuff like physics is selection bias because we swear by the physics we know but it could be entirely rubbish because it’s not the truth of Nature but just our best intuition of the truth of Nature which is of course subject to selection bias anthropomorphically speaking

First, you have to really understand what liquidity is. Liquidity isn't cash, or value per say, but rather a measure of how easy something is to trade. Cash just happens to be the most liquid thing because it is the most actively traded thing. For example, it's not like everyone trades for cars directly using chickens, but both chickens and cars are directly traded for cash, so cash is more liquid (ie easy to trade with) than either cars or chickens.

Next, excess liquidity can disappear by market participants simply refusing to do trade (ie a drop in demand). For example, if I have a house, which many people would be willing to trade for me today, tomorrow they could all change their minds and wouldn't even trade me a spoonful of dirt for it. In which case, the liquidity of my house (easiness to trade it), dried up by simply a change in market demand.

Now here's the best part, while every transaction has a buyer and seller, every transaction has two supplies and two demands. For example, person A may be willing to trade his supply of cars, but demands X dollars in exchange for any one of them, and person B is willing to trade his supply of dollars, but demands a car of certain condition for them. In this case, there are two supplies (dollars, and cars) and two demands (again dollars, and a car of a certain condition). If the supplies of each participant, meets the demands of the opposing participant, the transaction happens, and the trade is settled between the two parties.

So to address your questions. It's entirely possible for something that was easy to trade (cash), was traded for [houses/stocks/commodities/etc], and afterwards, no one is willing to trade things anymore. Which includes people with houses who are not willing to trade them for cash, and people with cash no longer willing to trade them for houses. Liquidity disappeared simply by a change in market demand. But you're not necessarily wrong, as if demand doesn't change, then it doesn't really dry up.

You’re on the right track. Many people including economists don’t get this. It’s a very useful way of thinking economically.

(See also my other comment here).

Yeah I've also wondered the same, i.e. I view it as a closed system and excess liquidity usually results in inflation until demand matches supply of money

Excess liquidity gets eventually absorbed in the form of broad inflation. I.e. the money loses the excess value.

>If other than central banks have excessive liquidity they may trade it for other assets. This means they need to find a counter party that has the reverse situation. So overall the economy cannot have excessive money.

But you are assuming that there is no zero lower bound. If there is an excess of liquidity like there being an excess of trash then people would expect to get paid to get rid of it and the market would just find a garbage collection fee for this excess liquidity. But if there is a zero lower bound, then the people with the excess liquidity have no incentive to dispose of it. Instead, they would just keep accumulating more and more liquidity indefinitely as the market tells (or rather is forbidden to tell) them there is no excess liquidity.

I mean, take this example. The interest rate in the market is 3% and the interest set by the central bank is 5%. People will accumulate more liquidity than is optimal. There will be an excess of liquidity. It doesn't matter what the absolute numbers are. They can be -3% and 0% and you run into the same problem.

If excess liquidity is a form of economic pollution like CO2 is, then you would expect to pay for this pollution. But since the government doesn't charge a pollution tax, people will overproduce both CO2 and excess liquidity.

The rationale that seems most reasonable to me is decades of low interest rates.

Interest rates are essentially an indication of how expensive money is. When interest rates are low, money is "cheap".

Outside of the FED purchasing bonds, Banks giving loans is another way to "print money". So when interest rates are low, more people and businesses take out loans, and as a consequence there is more money circulating, "sloshing around", in the economy.

There are other factors at work though, outside of interest rates, that can cause wealth to pool.

Various forces since the mid-1990s in the United States, mostly related to the tax and regulatory environment of corporate compensation packages (i.e. paying senior employees in stock, etc), have caused net wealth transfers to the upper classes. The wealth gains those classes have achieved also causes them to have excess wealth that wants to go somewhere.

In shipping industry, to avoid sloshing which could destablize the oil containers, you compartmentalize.