Question about "liquidity" problems

greenspun.com : LUSENET : TimeBomb 2000 (Y2000) : One Thread

As people prepare for y2k I keep reading where companies are borrowing ahead of y2k in order to insure having enough cash should something happen. Due to this, I've also heard that this is causing lending rates to go up due to less and less cash available. As we approach year end I can see this accelerating, thus causing a potentially large cash shortage come year end. Could someone in the know please tell me what some of the bi-products of a liquidity crunch might be? Might this in itself cause inflation? If there is a shortage of money to loan, would the shortage affect the 50 billion that the feds have printed up for the general public, or is that a separate thing? Thanks

-- Richard (trubeliever@webtv.net), September 04, 1999

Answers

Richard, the currency that the Mint is printing has practically nothing to do with liquidity concerns in the bond market.

A news item which causes bond market liquidity to dry up could also cause consumers to run to their bank to convert deposits to actual dollar bills ("currency"), but bond market liquidity is not the same thing as currency availability.

Large companies are borrowing billions of dollars now because they are concerned that people may not want to lend them money in the last three months of this year. These companies most likely have absolutely no worries about the availability of "cash" (if you use that word as a synonym for currency or actual paper dollar bills), but the companies are worried about their ability to persuade lenders to make loans in Oct. Nov and December.

As far as whether the borrowing trend will accelerate at the end of the year, I think most money managers are assuming that the big rush is right now and that corporate demand will be much lighter overall in December, although there might be a rush to invest in certain types of instruments at the end of the year.

The printing and availability of dollar bills will have absolutely no effect on inflation. But if the public perceived that either inflation or deflation were about to become rampant, there might be a big demand on dollar bills to fund purchases of physical assets or to put bills in what a saver may believe to be a safer environment than the ledger book of a financial institution.

-- Puddintame (achillesg@hotmail.com), September 04, 1999.


You have to be careful on how you read these things, the word "cash" does not necessarily literally mean greenbacks being stuffed under the CEO's mattress. Usually, cash really means an electronic promise to pay that can be converted easily to cash, such as a bank account. Of course, what you can easily convert to cash today may not hold true in four months.

People are always trying to think up ways to have "cash" without it really being currency. Everything from travellers checks to money orders has been recommended. The reality is that "Cash Is King", and if you are going to protect yourself from what is coming, it behooves you to stockpile greenbacks and coins, while you still can. Remember, if just a few percent of the population got this bright idea and tried to do it, either currency would be exhausted because there is so little (like $1.17 for every $100 in bank deposits), or banks would impose limits on how much you can withdraw.

-- King of Spain (madrid@aol.com), September 04, 1999.

Hey King...

Maybe the banks will let us wrestle in a puddle of greenbacks? If we oil up real good... maybe some will stick.

:o)

-- eubie (eubie@bankrun.com), September 04, 1999.


>> Could someone in the know please tell me what some of the bi-products of a liquidity crunch might be? Might this in itself cause inflation? <<

A liquidity crunch is reasonably simple to understand. It happens when assets come to market and there are few or no buyers. The seller cannot "liquidate" his asset and must hold it, or lower the price until a buyer comes forward. If the seller has obligations to meet, and *must* liquidate that asset to raise cash, the seller often doesn't have the option of holding and must lower the price. That is why a liquidity crunch leads to falling asset prices.

Consider your own assets. They might include a home, a car, some stocks or bonds, the cash in your bank account and two cases of canned tomatoes in the basement. Some of these are more liquid than others. But in a true liquidity crunch only the cash on hand is liable to keep its value unimpaired. If you don't have enough cash to pay your bills, and your income is drying up, you will need to liquidate some of your assets to get more cash to cover your bills.

Businesses and investors are in *exactly* the same boat. They need have incomes, hold assets and have bills to pay. These have to balance out. When the income doesn't cover expenses, and they can't get credit to meet obligations, they must liquidate assets. When every business and every investor is caught in this position, markets crash. Those who have cash want to keep it rather than plow it into illiquid assets. Buyers evaporate. Sellers put assets to panic prices. You know the drill, I'm sure.

-- Brian McLaughlin (brianm@ims.com), September 04, 1999.


Richard,

To put it in another way, to the companies that are doing the borrowing that you are reading about, a balance in their checking account is regarded as cash. They simply want to be sure that when they issue checks, that the checks do not bounce. They are NOT gathering "greenbacks", so their actions are not competing with those of people who do want greenbacks.

Jerry

-- Jerry B (skeptic76@erols.com), September 04, 1999.



The risk with a liquidity crisis is that of severe distortions outside the normal range of behavior for financial markets. In other words, things tend to function within the bell curve during normal times, while during a liquidity crisis abberrations can appear which will severely hamper a country, or corporations ability to conduct normal business operations. For speculators, ala LTCM and others, the consequences can be severe. Depending on the size of their positions, they can then bring down the house so to speak.

-- Gordon (g_gecko_69@hotmail.com), September 04, 1999.

Corporate borrowing in advance of Y2K is deflationary: Get cash now because it will have greater buying power in the future.

Corporate borrowing is like a bank run but with more class - instead of running to get your deposits before another depositor can get theirs, the advanced corporate bond issuers are beating other corporations out of the competion for capital. There is not an infinite sum of money available to the corporations so those that are late to get their bonds issued will either have to offer a higher interest rate to attract investors or be locked out of the bond market.

This in itself could lead to some bankruptcies pre-Y2K for firms that are operating close to the edge and fail to refinance credit lines or get financing for continued operations.

Inflation may come much later when the extra cash reserves come back into the stock and commodity markets.

-- Bill P (porterwn@one.net), September 04, 1999.


Moderation questions? read the FAQ