There's Money. And there's Liquidity!
Lenders lend if they can profit. Borrowers borrow if they can afford it.
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We all know what money is, right? Money is cold hard cash! The stuff you buy groceries with. Stuff you keep in a bank. Retirement and security. Liquidity.
Here's what Doug Noland said about money in The Power of Money, the May 4, 2001 article in his series, The Credit Bubble Bulletin:
We must now face squarely the question of the meaning of liquidity. There are no liquid assets aside from money, unless there is a central bank. In the discussions of liquid assets, it is significant that cash, bank deposits, and government securities are the only things ordinarily considered. Other securities and commodities are not added in when statistical estimates are made. Possibly this is a recognition of the painful truth learned in frequent panics under a national banking system that only a central bank can create liquidity. ... The liquidity of things which may not be absorbed by the central bank is a fair-weather phenomenon. Nonetheless, this fair-weather liquidity is a matter of significance and requires consideration. To the extent that liquidity preference is satisfied in periods of calm by assets that prove to be illiquid in periods of stress, the system is rendered more unstable.
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Before the current crash, the money markets had become a huge source of credit, for both the housing and equity markets. This multiplied the quantity of money many times. First, credit is like cash, right? With credit you can buy anything. Trouble is, you can't pay for what you buy without real cash!
Quoting again from The Power of Money, here's what Noland had to say:
Today, the money and capital markets have come to dominate the money and credit creation process, with non-bank financial intermediaries at the heart of the U.S. Credit Bubble. ... Specifically, an historic monetary expansion ("multiplication") has created money market fund deposits in excess of $2 trillion. [Multiplication occurs because the borrower can lend the money to someone else, who can lend it to ....] ... As long as confidence holds, credit in the form of money has virtually unlimited potential for expansion.
Lenders will keep lending if they can keep borrowing short-term at a low interest rate and lending long-term at a higher interest rate. And borrowers will keep borrowing if the cost of borrowing (interest rate) is low enough to be affordable.
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