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Financial Times Letters

Daniel Aronoff

Financial times

FT

Daniel j aronoff

landon companies

Desire for liquididty comes at a cost investors struggle to grasp/FT 10-8-2015

October 8, 2015 11:49 pm

Desire for liquidity comes at a cost investors struggle to grasp

From: Daniel J. Aronoff

Sir,

Martin Wolf presciently warns of the danger posed by over-dependence on market liquidity (“Beware of the liquidity delusion”, Comment, Oct 7). As Keynes explained, a system dependent on liquidity is prone to crisis because the market as a whole is not liquid; in the short run, the volume of capital assets is fixed. While the central bank can manufacture liquidity — as it did during the recent financial crisis — it comes at a cost. The channel by which money is created bloats the balance sheet of the central bank and floods the commercial banking system with excess reserves. The assets acquired by the central bank can wind up costing taxpayers money if they lose value. The excess reserves will enable the private banking system to grow lending and deposits without limit once banks are fully recapitalised. The excess lending can fuel another credit bubble and the deposit growth can trigger inflation. These are risks we are now living with.

There is no easy solution to the problem Mr Wolf warns of. A tax on securities transactions might be an effective way to discipline investors to allocate their capital in accordance with their best judgment of the long-term prospects of the businesses that issue the securities. This would be an improvement on the two predominate modes of investing today, which are to speculate on impending securities price movements or to invest in indices without judgment of the underlying prospects. A transaction tax would also slow the exit from securities into money during a panic.

Keynes considered and rejected this option because he worried that the desire for liquidity — even if it is founded upon an illusion — was so prevalent that investors might shun illiquid securities in favour of hoarding or lending money. If that were to occur, capital investment would decline. Nevertheless, this is a problem that should command the attention of policymakers at the highest levels.

Daniel J Aronoff

President, The Landon Companies

Birmingham, MI, US

Copyright The Financial Times Limited 2015.