Back at the end of July, I argued that the contraction of liquidity being experienced then would mark a high point in asset markets and the global economy.
The damage is now spreading to credit creation by the banks, as the various vehicles used to move debt off balance sheets are reinstated (reintermediation). This uses up bank capital and forces lending to be curtailed as risk-free capital ratios are re-established. Next will come the asset write-downs.
The key drivers of contracting liquidity multipliers are falling risk appetite and a reversal of the yen carry trade. The former affects leverage and the latter the quantity of money available to undertake it.
As I have argued before, we are now in an era of New Monetarism, which means that long gone are the days when central banks controlled money supply through the emission of power money and the imposition of reserve ratios on banks. Now it is essentially risk appetite that drives leverage, which in turn determines liquidity.
Contraction
I reckon global credit could contract by 8% to 12% in the next year, as the initial credit contraction causes other asset prices to fall and further write-downs then have to be made and credit growth cut again...