The Liquidity Puzzle
We increasingly hear that “the world is awash with liquidity,” and that this justifies expecting asset prices to continue rising. But what does such liquidity mean, and is there really reason to expect that it will sustain further increases in stock and real estate prices?
Liquid assets are assets that resemble cash, because they can easily be converted into cash and used to buy other assets. The idea seems to be that there are a lot of liquid assets lying around, and that they are being used to get money to bid up the prices of stocks, housing, land, art, etc.
That theory sounds as general and fundamental as the theory that global warming is melting glaciers and raising sea levels around the world. Rising sea levels would explain a lot of geological and economic events. Is rising financial liquidity really a similar force? What is this theory anyway?