What Defines Liquidity?

MZM (money at zero maturity) is generally acknowledged as a useful metric for measuring liquidity. Recently, some investment strategists have noted that the current injection of funds into the US financial system by the Fed has boosted MZM to levels not seen since just after 9/11. The conclusion reached is the beneficial effects such liquidity increases are likely to have on financial assets. What is worth noting, however, is what is contained in the chart to your left*.

This data shows that while money growth has recently climbed, the increase (year over year) is still well below the 20% increase in liquidity that occurred in late 2001. What could be argued is the suggestion that the recent rise in liquidity simply offsets the draining of excess liquidity from the system that took place earlier this decade, which ended back in early 2005.

The value in this data may be the ability to better quantify the liquidity rescue efforts of the Fed and other central banks. What complicates the analysis, however, is the global nature of money, its growth, and the free flow of capital, a by-product of globalization. With money growth originating from so many “creative” methods (courtesy the financial wizards), the Fed can do its part and pump money into the system in a variety of ways, but measuring money growth has been compromised. And that makes the task of knowing just how much money is in the system that much more difficult. Yet another unknown among many.

*To view a larger version of the chart, simply click on the image.