Thursday, November 11, 2010

Liquidity Black Holes About To Burst.

We at wiTdom caution reflects a concern lest we cry wolf.But sometimes there is a wolf. And if we are not prepared, we can be taken unawares.If we underestimate the scale of the crisis, we will underestimate the scale of response that is necessary. The wolf is upon us. We must arm. We r proud to say we where first to give sell call.Game of run for dollar has begun as suggested in our previous blogs this will make a fall in stocks,precious metals, base metals and reality in coming days.

Black holes are regions of space in which gravitational forces prevent matter and radiation escaping. This is a good analogy for the third phase of the neoliberal implosion: after the credit crunch and the crash we now have the black hole.Traders with short horizons and privately known loss limits interact in a market for a risky asset. Risk-averse, long horizon traders generate a downward sloping residual demand curve that faces the short-horizon traders. When the price falls close to the loss limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales become mutually reinforcing among the short term traders, and payoffs analogous to a bank run are generated. A ``liquidity black hole'' is the analogue of the run outcome in a bank run model. Short horizon traders sell because others sell. Using global game techniques, we solve for the unique trigger point at which the liquidity black hole comes into existence. Empirical implications include the sharp V-shaped pattern in prices around the time of the liquidity black hole.

With inflation close to zero, and tax and interest rate cuts apparently unable to reflate the economy, the system faces the danger of a “liquidity trap”. Capitalists will borrow money to invest only if they think they can make a profit. If demand is falling, and in particular if prices are falling, the fear is that eventual returns will not cover the cost of investments—even when interest rates are close to zero. The best thing then is simply to hoard money: if prices are falling, a cache of savings will buy more in the future.
It is when a liquidity trap threatens that cutting interest rates can be like “pushing on a piece of string”. This was a key feature of the Japanese crisis of the 1990s. Though interest rates were sometimes at zero and the Bank of Japan repeatedly pumped money into the system (the “quantitative easing” now much discussed), the economy stagnated. Capitalists and consumers continued to save rather than borrow.


Atul Sikrai

Sr Vice President & Head Equity

wiTdom investment advisory.