Mercers’ School Memorial Professor of Commerce Michael Mainelli

1. Mercers’ School Memorial Professor of CommerceMichael Mainelli Liquidity: Finance In Motion Or Evaporation?

2. Outline • Fluidity in definition • Time, value, probability and money • Settled dis-equilibria • Small holes • Liquidity and lucidity • Liquidity crises • Black holes, white bubbles • Trading on ice “Get a detailed grip on the big picture.”Chao Kli Ning

3. Fluidity In Definition “the probability that an asset can be converted into an expected amount of value within an expected amount of time” liquidity = certainty (value, time)

4. Who Needs Liquidity?

5. Caught Short (In Time)

6. Caught Short (In Value)

7. Caught Off-Guard (In All Probability) Certainty = % likelihood [value fall/rise + time fall/rise] Example: watch = [£1,000 – 50%(£500), 1 week + 50%(2 weeks)] = [£750, 2 weeks]

8. Liquid Measures • Resilience • Depth • Tightness [Source: Holl and Winn, 1995]

9. Monnaie des Sources [Source: http://www.bankofengland.co.uk/]

10. Where Has All The Money Gone? [Source: OECD]

11. Back To Basics [Source: http://en.wikipedia.org/wiki/Supply_and_demand]

12. Rising Price Lifts All Boats P Demand Supply P2 P1 Q Q1 Q2

13. Liquidity P’s, T’s & Q’s P Demand Supply P2 P1 T Q Q1 Q2

14. Not Smooth Curvature P Demand Supply P2 P1 T Q Q1 Q2

15. Not Continuous P Demand Supply P2 P1 Q T Q1 Q2

16. Liquidity Clouds Demand Supply P T ‘Normal’ liquidity risk Q

17. Predicting Price Movements [Source: Z/Yen Group Limited, 2005]

18. Liquidity Holes Demand Supply P T Q

19. Small versus Large [Source: Z/Yen Group Limited, 2002]

20. Bull or Bear?

21. Dark Liquidity Pools

22. Liquidity or Lucidity? Price Formation Transparency Liquidity Trading Competition Capital at Risk Regulation Exchange Competition Spreads Volatility Price Formation

23. With Apologies To Jonathan Swift So, financiers observe, small pools suck larger pools’ liquidity; yet tinier pools drain other drops, and so on to aridity.

24. Liquidity Crisis 2007?“Water, water, everywhere, nor any beer to sink.”

25. An Historical Perspective • Holy Roman Empire currency 1622 • Tulips 1636 • South Sea Scheme 1720 • Northern Europe 1763 • East India Company 1772 • Emerging markets 1809-1838 • Railways 1847-1873 • Commodities 1890-1920 • Great Crash of 1929 • Bretton Woods collapse 1973 • Savings & Loans 1980

26. A Modern Perspective • Third World Debt 1982 • Black Monday 1987 • Junk Bonds 1988 • Japanese Bubble 1990s • US Bond Crash 1994 • Mexican Crisis 1995 • Asian Crisis 1997 • Russian Crisis 1998 • Long Term Capital Management 1998 • Dotcom Crash 2000 • September 11 Disruption 2001 • Argentine Crisis 2002 • Credit Crunch 2007

27. Bubble, Bubble, Toil and Trouble Hyman Minsky’s Waterfall Hedge Speculative Ponzi

28. Ponzi Borrowers

29. Black Holes and White Bubbles

30. Modelling Financial Black Holes P Supply Demand P2 P1 Q Black Hole ‘Event Horizon’

31. Simple Really Brasil, India, Russia, China economic activity goods consumers markets companies access characteristics savings confidence & trust liquidity = certainty (value, timing) assets property financial institutions equities credit: default rates & rating agencies regulators commodities leverage money supply

32. Avoiding Liquidity Traps [Source: www.moneyfiles.org]

33. Discussion • Are all liquidity crises unique, or irrelevant, or useful - or are things different today? • When new markets emerge, from where does the liquidity come?

34. Liquidity: Finance In Motion Or Evaporation? Thank you! “Get a big picture grip on the details.”Chao Kli Ning