Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 49

Liquidity is abundant despite QE wind down

In 1974, the Whitlam Government was making its ill-fated moves to borrow USD4,000,000,000 from the surpluses of oil-exporting countries, and Australians quickly adopted the concept of billions to measure really big numbers. These days, we’re used to hearing things measured in trillions. A thousand billion. Last year’s US GDP was USD17 trillion and Australian superannuation assets have reached AUD1.75 trillion.

Plenty of liquidity

A recent report from Deutsche Bank caught my eye for its use of trillions to quantify the huge expansion in the balance sheets of central banks in the US, the Euro zone, Japan, UK and Switzerland. The five central banks “have delivered unprecedented monetary stimulus since the [global financial] crisis … Interest rates [have been] slashed to all-time lows [and] USD7 trillion in liquidity added since 2007 … These central banks will remain ultra-supportive, adding a further USD1 trillion of liquidity [in 2014]”.

Figure 1: USD8 trillion of additional liquidity, 2007-2014 DS Liquidity2

DS Liquidity2

What is 'liquidity'?

I should remind readers that the word ‘liquidity’, when used in discussions of financial markets, has several different meanings. It’s most often used to describe the ‘depth’ of a financial market: liquidity means that the buying or selling of a particular security doesn’t much affect the price at which it trades. Liquidity can also refer to the speed and ease with which a bank or insurance company can convert various assets into cash.

However, in discussions on monetary policy, liquidity refers to what a central bank is doing to the level of the money base. That is, the total of currency (notes and coin) on issue plus the level of deposits the commercial banks have with central bank (which can readily be converted into notes and coin). In turn, ‘liquidity creation’ (or ‘liquidity generation’) describes the expansion of the money base, or how much money is being printed.

A central bank creates liquidity when it buys bonds or other financial instruments, intervenes to keep the exchange rate down, or lends to banks or other financial institutions. In those circumstances, the central bank simultaneously acquires an asset (the bond, foreign exchange or loan) and increases its liabilities (the deposits that commercial banks hold with the central bank or the volume of currency on issue).

Central banks in developed economies have been doing ‘whatever it takes’ to increase spending and jobs and to avoid deflation; in the Euro zone, they’ve been keen also ‘to preserve the euro’.

No boost to business activity

To date, however, central banks haven’t succeeded in boosting business activity as much as they, and their governments, would like. That’s because, with many companies and households wanting to cut back on debt and with commercial banks taking a cautious view on lending, much of the additional liquidity isn’t circulating or giving rise to an expansion in credit; instead, it’s sitting around in idle balances. In the US, for example, commercial banks have USD2 trillion of excess reserves held on deposit with the Fed.

However, the massive creation of liquidity in recent years has greatly reduced the risks of another global recession and deflation. And in most developed economies it’s helped drive share prices and house prices higher.

The US Central Bank is expected to end its ‘quantitative easing’ (QE) by late 2014. Until recently, that programme was running at USD85 billion a month, but has since reduced. But that move – the ‘taper’ - will simply reduce the rate of build-up in liquidity. It will not result in the withdrawing of some of the massive increase in liquidity that’s already been generated. With the central banks of Europe and Japan apparently on course to move further along the paths of unconventional monetary policy, global liquidity is likely to rise strongly over the coming year. A recent move by the German constitutional court could complicate, and for a while delay, asset purchases by the European Central Bank, but the ECB will have no alternative to generating more liquidity if it is to preserve the euro.

Share markets in developed economies seem likely to benefit from the continuation of an ultra-easy setting in monetary policy by the major central banks. However, as average valuations of shares are so much higher than a year ago, the pace of liquidity-led gains is likely to be modest.

Anyone who misspent their youth studying economics would recall the concept of the velocity of circulation of money. Alas, there’s not much velocity at present. As and when confidence returns and money starts circulating again, central banks will find it hard to sufficiently reduce the volume of liquidity they’ve recently created.

Investors preparing for retirement need many years ahead to allow for the mounting risk of a powerful return of global inflation. Not yet, but in the medium term.


Don Stammer was for many years Director, Investment Strategy at Deutsche Bank Australia. He is currently a columnist for The Australian and an adviser to the Third Link Growth Fund, Altius Asset Management, Philo Capital and Centric Wealth. The views expressed are his alone.


Leave a Comment:



Is it all falling apart for central banks?

Three themes for emerging market debt in 2021

How Japan’s 'Abe-nomics' affects Australian investments


Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Australia’s bounty: is it just diversified luck?

Increases in commodity prices have fuelled global inflation while benefiting commodities exporters like Australia. Oftentimes, booms lead to busts and investors need to get the timing right on pricing cycles to be successful.

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Investment strategies

Five features of a fair performance fee, including a holiday

Most investors pay little attention to the performance fee on their fund but it can have a material impact on returns, especially if the structure is unfair. Check for these features and a coming fee holiday.


Ned Bell on why there’s a generational step change underway

During market dislocation events, investors react irrationally and it should be a great environment for active management. The last few years have been an easy ride on tech stocks but it's now all about quality.  

SMSF strategies

Meg on SMSFs: Powers of attorney for your fund

Granting an enduring power of attorney is an important decision for the trustees of an SMSF. There are alternatives and protections to consider including who should perform this vital role and when.


The great divergence: the evolution of the 'magnetic' workplace

The pandemic profoundly impacted the way we use real estate but in a post-pandemic environment, tenant preferences and behaviours are now providing more certainty to the outlook of our major real estate sectors.


Bank reporting season scorecard May 2022

A key feature of the May results for the banking sector was profits trending back to pre-Covid-19 levels, thanks to lower than expected unemployment and the growth in house prices.

Why gender diversity matters for investors

Companies with a boys’ club approach to leadership are a red flag for investors. On the other hand, companies that walk the talk on women in leadership roles perform better, potentially making them better investments. 


Is it all falling apart for central banks?

Central banks are unable to ignore the inflation in front of them, but underlying macro-economic conditions indicate that inflation may be transitory and the consequences of monetary tightening dangerous.



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.