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Is Global Liquidity Excessive?

Is Global Liquidity Excessive?. AFGAP and ALMA International Conference June 15th, 2007. Liquidity…. ….is a many-faceted concept. Liquidity can be defined in many ways*.

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Is Global Liquidity Excessive?

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  1. Is Global Liquidity Excessive? AFGAP and ALMA International Conference June 15th, 2007

  2. Liquidity…. www.dexia-am.com

  3. ….is a many-faceted concept Liquidity can be defined in many ways*. • Market liquidity: the ease with which an asset can be sold, particularly whether this can be done in large volume without depressing the price. • Institutional liquidity: an institution is liquid if its balance sheet has a high proportion of assets whose value can be quickly realized to meet debts. • Monetary liquidity: originally liquidity referred to base money. More loosely, it had come to be used as a general reflection of the stance of policy and monetary conditions. In this loose meaning, it can either be a price (an interest rate) or a quantity (one of the monetary aggregates or credit). (*) Stephen Grenville, The Lowy Institute for International Policy www.dexia-am.com

  4. A commonly held view is that “global liquidity” is excessive It is often argued that past excessive monetary liquidity has led to excessive institutional liquidity hence an increase in many asset prices and… … ,possibly, tomorrow an increase in goods and services’ prices. Policy rates (%) 7 6 United States 5 4 3 2 Euro area 1 Japan 0 07 99 00 01 02 03 04 05 06 Source: Thomson Datastream www.dexia-am.com

  5. How appropriate is this view? 1. Japan, the last place were interest rates remain close to zero, seems to affect global liquidity only marginally. 2. In the emerging world, institutional liquidity is high, will decrease only slowly and could impact some asset prices. 3. In the US and the euro area, despite high past growth in monetary aggregates, only firms may be more liquid than in the past 4. This rather reassuring view seems corroborated by a quick look at the present level of prices for the biggest asset classes (bonds, real estate and stocks) www.dexia-am.com

  6. Since the beginning of 2006, Japan has given up it’s quantitative easing policy Monetary policy targeting (Trillion yen) 35 30 25 20 15 10 5 0 98 99 00 01 02 03 04 05 06 Current deposits at the Bank Required reserves Source: Thomson Datastream www.dexia-am.com

  7. Carry trade is the main lever of the central bank: the liquidity “injected” in the ROW is relatively small... Japanese balance of payments (100 billions of Yen, 12 months moving average, annual rate) Short term loans Portfolio investment 250 200 150 150 100 50 50 -50 0 -50 -150 -100 -250 -150 -350 -200 -450 -250 92 94 96 98 00 02 04 06 00 01 02 03 04 05 06 07 Equity Securities Short term loans [ (-) = capital outflow] Debt securities Change in reserves [ (-) = increase in reserves] Source: Bank of Japan www.dexia-am.com

  8. … but monetary policy clearly affects the foreign exchange market Exchange rates and short term rates differentials Yen to one euro Yen to one dollar 123 4.2 166 3.6 122 3.4 4.0 160 3.2 120 3.8 3.0 3.6 118 154 2.8 3.4 2.6 116 115 3.2 148 2.4 O N D J F M A M O N D J F M A M 2006 2007 2006 2007 Yen to one dollar Yen to one euro Short term rates differential at June 08 (US minus Japan) [R.H.S.] Short term rates differential at June 08 (Euro minus Japan) [R.H.S.] Source: Thomson Datastream www.dexia-am.com

  9. Saving and investment in the saving-surplus regions 1984-2005 (% of the region’s GDP) Counterparts of the US current account deficit (billion dollars) 1 200 Asian NICs Middle East 45 43 1 000 38 35 33 800 25 28 15 23 600 5 18 84 88 92 96 00 04 84 88 92 96 00 04 400 Developing Asia Japan 43 43 200 38 38 33 33 0 . 28 28 2000 2001 2002 2003 2004 2005 2006 23 23 Middle East + Russia Euro area 18 18 Asia ex Japan Rest of the world 04 84 88 92 96 00 04 84 88 92 96 00 Saving Investment Japan 2.Today’s international payments imbalances are partly explained by high saving rates in emerging countries Source: IMF www.dexia-am.com

  10. This goes with an accumulation of liquid assets by private agents in Asia… Household financial assets structures in 2005 (% of total) Deposits as a percent of household financial assets and wealth distribution 70 R²= 0.52 Korea Korea 60 Japan 50 Japan 40 Deposits as a % total financial assets 30 Euro 6 20 US 10 US 0 20 30 40 50 60 70 0% 20% 40% 60% 80% 100% Wealth share of the lowest 90% Cash and deposits Bonds Pension funds and insurance Shares and other equity Sources: National central banks, Davies et al. ( 2006) Mutual funds Miscellaneous www.dexia-am.com

  11. …but also by public authorities in many emerging countries Memo: Forex reserves do underestimate the amount of external assets accumulated by some emerging countries Foreign exchange reserves ($ billions) 2500 Developing Asia 2000 1500 1000 500 98 00 02 04 06 800 1500 Eastern Europe China 600 1000 Western Hemisphere 400 The Middle East had $240 billions of Forex reserves in 2006, but more than $1500 billions in foreign assets. 500 Russia 200 Korea Africa Middle East 0 0 98 00 02 04 06 98 00 02 04 06 Source: Thomson Datastream www.dexia-am.com

  12. 3. In the United States, it is difficult to say that households are “excessively liquid” Households liquid assets (deposits and credit market) (% of disposable income) 120 110 100 90 80 52 62 72 82 92 02 (% of financial assets) (% of total assets) 40 25 35 20 30 25 15 20 15 10 52 62 72 82 92 02 52 62 72 82 92 02 Source: Thomson Datastream www.dexia-am.com

  13. But, compared to the recent past, the liquidity of firms has increased somewhat Non financial corporations liquid assets (% of internal funds) 250 200 150 100 50 52 62 72 82 92 02 (% of financial assets) (% of total assets) 50 10 40 8 30 6 20 4 10 0 2 52 62 72 82 92 02 52 62 72 82 92 02 Source: Thomson Datastream www.dexia-am.com

  14. In the euro area, the sharp rise in monetary aggregates has been driven more by firms than by households Currency and deposits as a share of total financial assets in the euro area* (%) M3 deposits by agent (1999 = 100) 36 190 Other Financial Intermediaries (as a share of GDP) 34 170 Households 32 M3 150 (1999 = 100) Non FinancialCorportations (as a share of gross operating surplus) 30 190 130 28 Amount 03 97 99 01 05 170 110 14 Houhesholds (as a share of disposable income) Non financial corporations 150 90 99 00 01 02 03 04 05 06 07 12 130 M3 deposits by agent (as a share of M3) 10 110 60 as a % of nominal GDP 8 90 97 99 01 03 05 40 99 00 01 02 03 04 05 06 07 (*) Euro area has been here approximated by aggregating the following economies: Germany, France, Italy, Spain, Netherlands and Belgium. 20 0 HHD NFC OFIs Sources: Thomson Datastream, ECB, National central banks www.dexia-am.com

  15. House prices dynamic simulation since 1999 450 OFHEO index 400 +15% 350 300 Estimated 250 200 150 100 92 94 96 98 00 02 04 06 08 4. In many developed economies, house prices seem to have increased exaggeratedly Nominal house prices (1996=100) 330 280 230 180 130 80 96 97 98 99 00 01 02 03 04 05 06 07 United States Spain France Sources: Thomson Datastream, Dexia-AM www.dexia-am.com

  16. But the same cannot be said of bond prices… Long term reference level for 10-year interest rates Euro area United States 16 16 Observed 10-year rate 14 14 Reference level 12 12 10 10 % % 8 8 6 6 5.0 Observed 10-year rate Reference level 4 4 4.1 2 2 0 0 70 75 80 85 90 95 00 05 70 75 80 85 90 95 00 05 Source: Dexia-AM www.dexia-am.com

  17. And recently, long term interest rates have been fluctuating mainly with revisions of monetary policy expectations Interest rates (%) United States Euro area 5.3 5.8 4.5 4.6 5.2 4.4 5.6 4.4 4.3 5.1 5.4 4.2 5.0 4.2 4.1 5.2 4.9 4.0 4.8 4.0 5.0 3.9 4.7 3.8 4.8 3.8 4.6 3.7 4.6 4.5 3.6 3.6 4.4 4.4 3.5 3.5 M A M J J A S O N D J F M A M M A M J J A S O N D J F M A M 2007 2007 2006 2006 3-month eurodollar - December 2008 3-month euribor – December 2008 10-year interest rate [R.H.S.] 10-year interest rate (Germany) [R.H.S.] Source: Thomson Datastream www.dexia-am.com

  18. Finally, despite their recent rise to record levels… Stock market indices In dollars 400 In local currencies (1980 = 100) MSCI EMU 300 S&P 1600 200 SP500 100 1200 Emerging countries 0 95 97 99 01 03 05 07 800 In local currencies In dollars DAX 30 600 300 400 Eastern Europe 250 Shanghai A share Latin America 400 200 Global TOPIX 0 150 200 80 84 88 92 96 00 04 Middle East 100 Nasdaq 100 Asia 0 50 97 98 99 00 01 02 03 04 05 06 07 2005 2006 2007 Source: Thomson Datastream www.dexia-am.com

  19. … developed countries’ stock markets are not overvalued SP 500 MSCI EMU 1600 300 Reference SP500 250 1200 200 Long term reference level 800 150 100 Reference 400 MSCI EMU 50 0 0 65 69 73 77 81 85 89 93 97 01 05 73 77 81 85 89 93 97 01 05 100 100 80 80 60 60 40 40 Observed gap % % 20 20 0 0 -20 -20 -40 -40 -60 -60 65 69 73 77 81 85 89 93 97 01 05 73 77 81 85 89 93 97 01 05 Source: Dexia-AM www.dexia-am.com

  20. To conclude: • There is no « global » excess liquidity. • There is no reason to expect a brutal change in global liquidity. • Some pockets of over-liquidity exist and this may affect some specific asset classes (emerging markets, private equity). www.dexia-am.com

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