What does “excess liquidity sloshing around the financial system” mean?

Here&#x27;s a mental model I find helpful for understanding <i>current</i> circumstances:<p>&quot;Quantitative easing&quot; 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 <i>private cash balances</i> -- what many call &quot;liquidity sloshing around.&quot;<p>Last year, some central banks started doing <i>the opposite</i>, &quot;quantitative tightening,&quot; 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&#x2F;agency-issued bonds). The result has been a gradual decrease in <i>private cash balances</i> -- one could call it &quot;liquidity evaporating.&quot;<p>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:<p><a href="https:&#x2F;&#x2F;www.federalreserve.gov&#x2F;monetarypolicy&#x2F;bst_recenttrends.htm" rel="nofollow">https:&#x2F;&#x2F;www.federalreserve.gov&#x2F;monetarypolicy&#x2F;bst_recenttren...</a><p>--<p>PS. I&#x27;m talking only about readily observable facts, not about &quot;excess liquidity&quot; 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&#x2F;stocks&#x2F;commodities&#x2F;other asset class]”.<p>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 &#x2F; 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.<p>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.<p>What am I getting wrong? Or is this just an often repeated falsehood?

&gt; 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.<p>I don&#x27;t think this is how people behave.<p>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.<p>Most people don&#x27;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 &quot;investments&quot; 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 <i>new money</i> created since 2008. Let that sink in.<p>2010s were quite unprecedented years in terms of new money (and hence new debt) created. The repercussions were everywhere; crazy VC funding (Uber&#x2F;Airbnb etc.,), insane tech salaries, record high stock markets and so on.<p>[1] <a href="https:&#x2F;&#x2F;fred.stlouisfed.org&#x2F;series&#x2F;WSHOMCB" rel="nofollow">https:&#x2F;&#x2F;fred.stlouisfed.org&#x2F;series&#x2F;WSHOMCB</a><p>[2] <a href="https:&#x2F;&#x2F;home.treasury.gov&#x2F;data&#x2F;troubled-assets-relief-program&#x2F;about-tarp" rel="nofollow">https:&#x2F;&#x2F;home.treasury.gov&#x2F;data&#x2F;troubled-assets-relief-progra...</a>

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&#x27;s a near perfect measurement of excess liquidity sloshing around the financial system<p>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.<p>There is always as much liquidity as is required. &quot;Excess liquidity&quot; flows around until it finds somebody where paying off the loan they hold is the &#x27;best use of funds&#x27;. 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 &#x27;equity&#x27;.<p>Increasing base rates is an artificial market intervention that <i>suppresses</i> asset prices. High asset prices, as with everything else priced high, is just a market signal to produce more of that particular asset.<p>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 &#x27;best use&#x27; of that liquidity).<p>All fairly straightforward once you accept there isn&#x27;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<p>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.<p>Also is there anything like &quot;excessive money&quot;? Where does it come from? Central banks don’t just print money. They trade it for usually governmental bonds.<p>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&#x27;ve been assuming that the &quot;excess liquidity sloshing around&quot; 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 &#x2F; engineering &#x2F; physics - <a href="https:&#x2F;&#x2F;en.wikipedia.org&#x2F;wiki&#x2F;Free_surface_effect" rel="nofollow">https:&#x2F;&#x2F;en.wikipedia.org&#x2F;wiki&#x2F;Free_surface_effect</a>

`Liquidity` = `Value` minus `Debt`<p>`Excess liquidity` simply means we were in the middle period where valuations increased, and debt levels hadn&#x27;t yet caught up, so new credit was being issued fast, and money from loans was entering the system accelerating the cycle.

I interpret &quot;excess liquidity&quot; 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.<p>i.e. There are more people with money that needs to be spent.<p>I interpret &quot;sloshing around&quot; 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).<p>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.<p>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.<p>With such a system the question &quot;excess liquidity sloshing around&quot; 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&#x27;t worth it but you can&#x27;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.<p>&gt; 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.<p>Seriously? This paragraph is fucking garbage.

This is tangential but I asked it in another thread a little too late. But with the Fed&#x27;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 &quot;no&quot; but I don&#x27;t understand why.

It means lots of new money has been created by loan formation as interest rates have been so low.<p>Thus assets will see their price rise. Certain hot assets will see large price rises.<p>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<p>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&#x27;s loosing its worth more quickly.