In his weekly market comment of June 18, 2012, John Hussman, manager of four Hussman funds, provided a detailed discussion of the origins of the European financial crisis and listed possible solutions. While the stock market likes liquidity – which comes in the various forms with monikers such as QE, Twist, or LTRO – the benefits are very short-term in nature and rarely “solve” anything. At best, liquidity buys time for corrective action, but does not reduce unmanageable debt loads or restructure unproductive aspects of a personal, national or global economy.
From the weekly comment: “Think of it this way. A liquidity crisis is when you write a check for more than the amount in your checking account. You suddenly realize that you need to sell [some assets] to cover it, but selling everything at once might only get you “fire sale” prices. In this case, you need a loan for a few weeks to give you time to work out of your securities position. Without that short-term “liquidity,” the check might bounce even though you really do have the assets to pay it off. In contrast, a solvency crisis is when the only asset you have to cover that check is an IOU from your Uncle Ernie, who keeps promising “I’ll pay you every dime as soon as I win it back on the ponies.”
Our caution regarding the economy and financial markets for several months has been driven by our view that central bank liquidity has hidden insolvency in various sectors of the global economy. Until these issues are corrected, the global economy will struggle to grow at the level it should.