Why are central bankers so concerned with liquidity? Is this sympathy for the plight of the hard-working bond trader? It is more likely they wonder if the lofty asset prices they have engineered with quantitative easing can be sustained.
By liquidity we mean our ability to sell an asset without material loss. In this sense, individual transactions can be liquid and some of us can find liquidity for some of our assets some of the time. But we cannot all withdraw our deposits from the bank the same day nor sell all our bonds and stocks at the same time.
In financial markets when we rush for the exits the doors get smaller. The system rests on a liquidity illusion. Keynes derided the idea that liquidity was a virtue, calling it an antisocial fetish that “forgets that there is no such thing as liquidity of investment for the community as a whole”.
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